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Loyens v. The Queen, 2003 DTC 355, 2003 TCC 214

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Docket: 2000-998(IT)G

BETWEEN:

WILLIAM H. LOYENS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

_______________________________________________________________

Appeal heard on common evidence with the appeal of Harry P. Loyens (2000-999(IT)G) on October 29, 30, 31, 2002 at London, Ontario

Before: The Honourable Judge Diane Campbell

Appearances:

Counsel for the Appellant:

Keith M. Trussler, Rebecca Krasnor

Counsel for the Respondent:

Richard Gobeil, Roger Leclaire and

Nicolas Simard

_______________________________________________________________

JUDGMENT

The appeal from the assessment made under the Income Tax Act for the 1993 taxation year is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 4th day of April 2003.

"Diane Campbell"

J.T.C.C.

Docket: 2000-999(IT)G

BETWEEN:

HARRY P. LOYENS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

_______________________________________________________________

Appeal heard on common evidence with the appeal of William H. Loyens (2000-998(IT)G) on October 29, 30, 31, 2002 at London, Ontario

Before: The Honourable Judge Diane Campbell

Appearances:

Counsel for the Appellant:

Keith M. Trussler, Rebecca Krasnor

Counsel for the Respondent:

Richard Gobeil, Roger Leclaire and

Nicolas Simard

_______________________________________________________________

JUDGMENT

The appeal from the assessment made under the Income Tax Act for the 1993 taxation year is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 4th day of April 2003.

"Diane Campbell"

J.T.C.C.

Citation: 2003TCC214

Date: 20030404

Dockets: 2000-998(IT)G

2000-999(IT)G

BETWEEN:

WILLIAM H. LOYENS,

HARRY P. LOYENS,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Campbell, J.

Introduction:

[1] These appeals are from assessments in respect to the 1993 taxation year for both Appellants. They were heard together on common evidence.

[2] The Appellants, Harry Loyens ("Harry") and William Loyens ("William"), are involved in the business of developing and selling real estate. This appeal arises as a result of a series of agreements dated November 30, 1993 (the "Agreements"). The Agreements purport to effect a sale of the beneficial interests of the Appellants in a piece of real property (the "Harrison Farm") to a numbered company owned by Eugene Drewlo. A series of agreements as opposed to one agreement was necessary in order to utilize losses in a corporation, Lobro Stables, owned by the Appellants.

[3] The Respondent challenges the validity of the Agreements. Specifically, the Respondent submits that the evidence shows that the Appellants sold the Harrison Farm to Eugene Drewlo on March 8, 1993. If the evidence substantiates this allegation, the Appellants would have had no interest in the Harrison Farm to sell on November 30, 1993 and the Agreements would constitute a sham.

[4] The Respondent submits in the alternative that if the proper sale date is November 30, 1993, these Agreements do not achieve the tax savings purpose for which they were designed due to two reasons. First, the Agreements purporting to effect a section 85 rollover were invalidly executed because real property inventory is not eligible property. Second, the general anti-avoidance rule ("GAAR") applies, denying the Appellants any tax benefit from the Agreements of November 30, 1993.

Issues

[5] These appeals give rise to four issues. Three issues are common to both appeals of Harry and William while the fourth issue - the waiver issue - is relevant to Harry's appeal only. The issues are:

(1) Is the effective sale date of the Harrison property, March 8, 1993 or November 30, 1993?

(2) If the sale date is November 30, 1993, is the rollover of the Varna partnership interest to Lobro Stables valid pursuant to the application of subsections 85(1) and 85(1.1) of the Act?

(3) Does the general anti-avoidance rule, section 245 of the Act, apply?

(4) Is the waiver received by the CCRA on behalf of Harry a valid and effective waiver?

The Facts:

[6] William started building houses in 1959. Harry became involved in land development around 1980, when the company he managed, Walloy Excavating Company Limited ("Walloy") went into the land development business. Walloy had an excavating and ready-mix concrete business. Harry and William each owned 25% of the shares of Walloy, with another individual, Bill Wasko, who owned 50%. Bill Wasko also had interests in a company called Ardshell Limited ("Ardshell"). Ardshell had acquired a parcel of land to develop ("the Rosecliffe development") but was experiencing financial difficulties. Consequently, Walloy purchased Ardshell and Walloy became the 100% shareholder. Eugene Drewlo expressed interest in becoming a partner of Ardshell. Walloy had connections to Drewlo because Walloy supplied Drewlo with ready-mixed concrete for construction of Drewlo's apartment buildings. In the end Drewlo acquired 50% of the shares of Ardshell through his company, Drewlo Holdings Ltd. Ardshell's two corporate shareholders were now Walloy and Drewlo Holdings. The Rosecliffe development made money and Ardshell took on several other development projects.

[7] The Appellants, together with Bill Wasko, purchased in equal shares approximately one hundred acres for $100,000.00 in London Township in the late 1960s or early 1970s for development. This property was the Harrison property. It was not developed immediately but was used to grow hay. The Appellants had a particular fondness for this property. They indicated they would have purchased this farm without Bill Wasko if they had been financially able to do so. The equal shares in this property were different from the division of the shares each held in Walloy.

[8] Eugene Drewlo, whose company Drewlo Holdings had become a 50% shareholder of Ardshell, also owned the adjacent farm to the west of the Harrison property. He made an offer on the Harrison Farm but the Appellants were not interested in selling the entire farm. After negotiations they agreed to sell one-half of the farm for approximately $400,000.00.

[9] 722973 Ontario Limited ("722973") was incorporated to act as trustee to hold the beneficial interests of the owners of the Harrison property. The corporate shareholdings of 722973, reflecting the beneficial ownership of the Harrison property, were as follows:

William Loyens

16.7%

Harry Loyens

16.7%

William Wasko

16.7%

Drewlo Holdings Inc.

50%

[10] Harry and Drewlo were managing Ardshell during these years in its land development endeavours. One of its projects, the Hunt Club development, was struggling. It had been purchased for $16,500,000.00 but was experiencing cash flow problems. At this time, one of the most potentially lucrative pieces of property in the City of London became available. The Appellants felt that this property, if developed, could successfully offset the financial difficulties of the Hunt Club development. The University offered this property for sale by tender. Since Ardshell was struggling financially, it was unable to come up with $1,000,000.00 deposit required to accompany this tender. The Bank advised them that there was insufficient time to arrange a loan because of the tender deadline and suggested that Drewlo use his line of credit. Immediately after the meeting with their banker, Drewlo, Wasko and both Appellants discussed borrowing $1,000,000.00 from Drewlo at their lawyer's office. They were at the solicitor's office to execute deeds for a number of lots that had been sold. They used the solicitor's boardroom for this discussion but the solicitor was not present. According to the evidence of the Appellants, Drewlo agreed to this loan because "he really wanted that property too". During this meeting, which occurred on March 8, 1993, three cheques were drawn upon the account of Drewlo Holdings Inc. for a total of $1,000,000.00. Bill Wasko, Harry and William each received a cheque for $333,333.00. Drewlo requested security and it was agreed that the security would be the Harrison Farm property in exchange for these loans so that the tender could be submitted. The evidence disclosed that there was some hesitation in putting up this property as it was worth more than $1,000,000.00 but the Appellants stated that they anticipated repaying the Drewlo loan as the university land was worth "mega bucks". Even if the tender was not accepted, the deposit would be promptly returned. In describing this arrangement, William stated: "... if we don't pay him (Drewlo) back in six months he gets the land ... And we had a handshake on it". The arrangement was to be approximately six months in duration. According to the Appellants, since they were borrowing personally and providing security that was worth maybe $1,000,000.00 to $2,000,000.00, they agreed that the loan to the Appellants and Wasko would be in the amount of $1,000,000.00, sufficient to cover Walloy's share of the tender in the amount of $500,000.00 which Ardshell planned to submit. Each Appellant and Wasko received a cheque for $333,333.00. All three cheques were endorsed and cashed at the Bank of Nova Scotia on March 8, 1993. Each cheque contained the following notation in the lower left hand corner:

Re sale 722923 Ont. Ltd.

[11] To the best of William's recollection, he thought Harry completed the data on the cheques before Drewlo signed them and that the amount was mechanically imprinted. He stated he did not see the notation on the lower left hand corner being affixed to each cheque and that he did not recognize the writing. He stated that the notations were not on the cheques when he saw them at the solicitor's office before deposit and if they had been there he would have questioned it. Harry deposited William's cheque for him. Eventually, when he was informed of the existence of these cheque notations, he questioned Harry, Wasko, Drewlo and also his bank manager.

[12] Harry confirmed that he completed the data on the three cheques except for the amount which was stamped by a cheque writer. He stated Drewlo signed the cheques in the presence of himself, his brother, and Wasko. In denying that these notations were on the cheques while in his possession, he stated "If that had been put on the cheque I wouldn't have cashed it".

[13] Drewlo's evidence confirmed the testimony of the Appellants. When asked how the notation might have appeared on the cheques he responded "No, it was news to me when I heard about it".

[14] Each Appellant's cheque was deposited to their personal chequing account. On the same day, each Appellant deposited the sum of $175,000.00 in Walloy's account for a total of $350,000.00 to offset their obligations to Ardshell. The balance of $158,333.00 remained in each of their personal accounts.

[15] Ardshell did have the highest bid. However, when the University changed its mind it did not return the million-dollar deposit immediately. When the deposit was eventually returned, instead of repaying Drewlo, the Appellants deposited their share to Ardshell's account to offset its overdraft and their share of its debt load.

[16] By the fall of 1993, according to the Appellants, Eugene Drewlo was requesting either the return of his money or the transfer of the Harrison property. The Appellants could not pay. Their accountant, Bill Hill, was contacted to accomplish the property transfer to Drewlo. According to the Appellants, the sale of the Harrison property occurred on November 30, 1993. According to the Respondent, the sale took place on March 8, 1993 when Drewlo gave cheques to each Appellant and Wasko.

Issue One: Is the effective sale date of the Harrison property, March 8, 1993 or November 30, 1993?

[17] The parties disagree on the disposition date of the Harrison property. The Appellants submit the disposition date is November 30, 1993 while the Respondent submits it is March 8, 1993. If the evidence shows that the disposition date is in fact March 8, 1993, then the November 30, 1993 sale is a sham.

Appellants' Position:

[18] The November 30, 1993 Agreements are not a sham because there was a total absence of deceit, which is central to the sham doctrine. The tax plan devised by Hill does not mislead. The documents of November 30, 1993 represented nothing more than exactly what they purported to be.

[19] The Appellants did not terminate their interest in the property on March 8, 1993 because only specific events can result in such termination (Sheppv. The Queen, 99 DTC 510 (T.C.C.)). There is no evidence of any enforceable or firm commitment to purchase this property prior to November 30, 1993. Nor was there any change in possession, use or risk, as contemplated in Johnson et al. v. The Queen, 99 DTC 603 (T.C.C.).

[20] The Statute of Frauds, R.S.O. 1990, c.s. 19, required written documentation to support a sale of real property. The cheque notation relied upon by the Respondent to support a disposition date of March 8, 1993 is insufficient according to case law.

Respondent's Position:

[21] The March 8, 1993 transaction was in fact the sale of 722973 shares held by the Appellants and Wasko to Drewlo for $1,500,000.00, which included the assumption of the $500,000.00 mortgage. This represents the actual transaction and relationship between the parties.

[22] The effective sale of the Harrison property occurred on March 8, 1993, as evidenced by the three cheques from Drewlo Holdings to each Appellant and William Wasko for $333,333.00, the Bank's microfiche, the share registry plus supporting directors' resolutions and the corporate bookkeeping records of Drewlo Holdings.

[23] Acceptance and endorsement of the cheques are evidence that the sale occurred on March 8, 1993 because each cheque had a memo, written in the lower left hand corner which read: "Sale of 722973 Ont. Ltd.". The cheques plus the other documentation, relied on by the Respondent, support a sale date of March 8, 1993 and amount to "consensus ad item" between the parties. In addition the bank's microfiche copies of these cheques contain the same notation.

[24] The facts do not support the allegation that Ardshell required the money to finance $1,000,000.00 tender on a property because each of the cheques for $333,333.00 was deposited in each of the Appellants' personal accounts and on the same day, each Appellant then deposited $175,000.00 for a total of $350,000.00 to Walloy. Amounts loaned to the Appellants and the cash requirements of Ardshell do not match with their proportionate share of the corporate debt. Ardshell's shareholders, Walloy and Drewlo Holdings, were required to inject equal amounts, i.e. $500,000.00 each. Walloy however injected $700,000.00.

[25] The share registry and corporate resolutions of 722973 made no reference to the Varna partnership or Lobro Stables. In addition, the corporate bookkeeping records of Drewlo Holdings contained an original journal entry which labelled the $1,000,000.00 paid to the Appellants and Wasko as an investment. On November 30, an adjusting entry was made which removed the $1,000,000.00 out of investments and into accounts receivable. This amounts to a deliberate recharacterization from an investment to an account receivable. The November 30, 1993 Agreements were tax-planning after-thoughts.

Analysis

[26] The term "sham" is defined in StubartInvestments Limited v. The Queen, 84 DTC 6305. That case referred to the parameters of a sham transaction at paragraph 50 where the Court quoted from the case of Snook v. London & West Riding Investments, Ltd., [1967] 1 All E.R. 518 at page 528, which found that no sham existed because no acts had been taken:

...which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.

[27] The disposition date of the Harrison property will ultimately determine whether a sham transaction occurred in this case. The existence of sham was crucial to the Respondent's position. The Respondent argued that the November 30, 1993 transactions did not represent the actual relationship between the parties and were in fact a sham. Shell Canada Ltd. v. R., [1999] 4 C.T.C. 313 at paragraph 39 referred to legal relationships in relation to sham:

This Court has repeatedly held that courts must be sensitive to the economic realities of a particular transaction, rather than being bound to what first appears to be its legal form: BronfmanTrust, supra, at pp. 52-53, per Dickson C.J.; Tennant, supra, at para. 26, per Iacobucci J. But there are at least two caveats to this rule. First, this Court has never held that the economic realities of a situation can be used to recharacterize a taxpayer's bona fide legal relationships. To the contrary, we have held that, absent a specific provision of the Act to the contrary or a finding that they are a sham, the taxpayer's legal relationships must be respected in tax cases. Recharacterization is only permissible if the label attached by the taxpayer to the particular transaction does not properly reflect its actual legal effect: Continental Bank of Canada v. R.,[1998] 2 S.C.R. 298 (S.C.C.) at para. 21, per Bastarache J.

[28] Before looking at the documentary evidence, it will be useful to summarize the evidence of both Appellants and Drewlo as to their explanation of the March and November events. The oral evidence of both Appellants and Eugene Drewlo confirmed that they formed a business relationship when Drewlo purchased a 50% interest in Ardshell. The other 50% interest was owned by Walloy Excavating. Ardshell successfully completed a development called Rosecliffe. However, by March 1993 one of the subsequent developments, Hunt Club, was not financially successful. When a potentially lucrative property came up for tender through the University, Ardshell wanted to bid but did not have the $1,000,000.00 deposit required to accompany the bid. The Bank advised the Appellants, Drewlo and Wasko, that there was insufficient time to process a loan for $1,000,000.00 and that Drewlo should use his line of credit.

[29] The Appellants and Drewlo all gave evidence which confirmed that this was the backdrop to the transaction of March 8, 1993. When these individuals left the Bank, they went to their solicitor's office where the deal was struck. As Ardshell was struggling financially, Drewlo agreed to loan $1,000,000.00 to Harry, William and Wasko. This loan was to be used to cover Walloy's one-half share of the deposit as well as their share of other Ardshell debts. Drewlo asked for the Harrison property for security. The evidence confirmed that when they agreed on the loan and the security, Drewlo wrote three cheques of $333,333.00 each to Harry, William and Wasko. Ardshell was the successful bidder but the vendor backed out of the deal. Some of the loan to each of the Appellants was used to pay off the debt load of Ardshell so they were unable to repay Drewlo. Eventually Drewlo wanted the loan repaid and because they were unable to do so, the balance of Harrison property was conveyed to one of his companies in the manner set out in Hill's memo.

[30] I turn now to the documentary evidence, which included:

1) the November 30, 1993 Agreements;

2) the March 8, 1993 cheques;

3) the accounting entries;

4) the interests' adjustment; and

5) the corporate resolutions.

To understand the November 30, 1993 Agreements, it is essential to look at Hill's memo to the solicitor (Exhibit A-1, Tab 30). I have reproduced the memo in its entirety:

BILL & HARRY LOYENS

_________

1. Presently Bill and Harry Loyens along with Bill Wasko own 50% of a farm property referred to as the Harrison Farm. They each have a 1/3rd interest in the 50% 722973 Ontario Limited as a bare trustee corporation holds 50% of the property in trust for these individuals remaining 50% is held in trust for Drewlo Holdings Inc.

2. Bill and Harry Loyens wish to transfer their interests to a partnership called Varna Elevators. At present they are the only partners and each has a 50% partnership interest. They would be transferring their beneficial interest only as 722973 Ontario Limited would continue to hold legal title.

The fair market value of the property is $500,000 each and there is $166,667 loan outstanding ($333,333 in total). Bill and Harry and the partnership will elect to have Section 97(2) apply and each will elect to have the transfer apply at $166,667 for tax purposes. Consideration for the transfer will be assumption of the debt of $166,667 and a credit to the partner's capital account of $333,333. Please prepare the necessary transfer documentation.

3. Following completion of the transfer as outlined in 2) above Harry Loyens will transfer his partnership in Varna Elevators to Lobro Stables (1991) Ltd. Consideration for the transfer will be the issuance of Class A special shares having a redemption amount equal to the fair market value of the partnership interest. The parties will agree to have the transfer subject to the provisions of Section 85 of the Income Tax Act and agree that the elected amount shall be equal to Harry Loyens adjusted cost base of his partnership interest which amount is to be determined. The paid up capital of the special shares should be limited to the election amount.

Note:

We understand that it will be necessary to have a class of special shares created in Lobro. We would suggest the following attributes:

4. Bill Loyens will then transfer his partnership in Varna Elevator to Lobro Stables (1991) Ltd. Consideration elected amounts, etc. will be the same as set out in item 3.

5. Through these steps beneficial title in the Harrison Farm property formerly owned by Bill and Harry Loyens has been transferred to Lobro Stables (1991) Ltd.

6. Lobro Stables (1991) Ltd. and Bill Wasko will then sell their interest in the Harrison Farm to 643288 Ontario Ltd. The selling price is $1,500,000 with the consideration being the assumption of debt for $500,000 and a note payable to Lobro Stables (1991) Ltd. for $666,667 and Bill Wasko for $333,333. Closing of this sale must be on November 30th. Please prepare the usual purchase and sale agreement.

7. Previously Drewlo Holdings advanced $333,333 to Bill, Harry and Bill Wasko. We propose to treat these advances as a loan during the interim period. After the closing of the sale in 6 all parties should agree that all notes are cancelled by set-off.

8. We will transfer the notes payable by Bill and Harry to Lobro by reducing their shareholder loans in that company.

643288 Ontario Limited

1. As set out in point 6 of the Loyens memo this company will be acquiring the Harrison Farm (50%) for $1,500,000.

2. The set off procedures for the notes results in a $1,000,000 payment by Drewlo to 643288. In addition Drewlo will assume the $500,000 bank loan thereby increasing the payment to $1,500,000. This is to be treated as a $1,500,000 repayment by Drewlo on its loan from 643288. We will ask that you prepare an acknowledgement of this for Drewlo Holdings Inc. and 643288 signatures.

I can be reached at Queen Elizabeth Hotel in Montreal: 514-861-3511, Room 1646.

I will check regularly for messages.

Our apology for the time pressure on this.

Regards,

W.J. Hill*mh

[31] Prior to November 30, 1993, 722973 was the registered owner of the Harrison property, holding it as bare trustee for the shareholders. Pursuant to Hill's memo, the Appellants, by Agreement dated November 30, 1993, transferred their 16.7% beneficial interest in the Harrison property to their partnership, Varna Elevators ("Varna partnership"). The Appellants were equal partners in the Varna partnership. This transfer was carried out pursuant to subsection 97(2) of the Act. The total consideration received by each Appellant consisted of an assumption of liabilities of $166,667.00 and a partnership interest of $333,333.00, totalling $500,000.00 consideration for each Appellant. Each Appellant reported taxable business income of $133,333.00. Again 722973 acted as bare trustee for the Varna partnership with respect to the partnership's beneficial interest in the Harrison property.

[32] Subsequently, on the same day, each Appellant by separate document dated November 30, 1993 transferred their partnership interest from the Varna partnership to their company, Lobro Stables (1991) Ltd. ("Lobro Stables"). Again these transfers were in accordance with Hill's November memo. The Appellants filed an election pursuant to section 85 of the Act for the disposition of the partnership interest in Varna to Lobro Stables. The T2057 elections specified a fair market value for each individual partnership interest as at November 30, 1993 of $281,000.00. The consideration received by each Appellant was paid by the allotment and issuance of 2,180 Class A Special shares. Subject to the section 85 election, the agreed transfer amount was $1.00. Since the Varna partnership had a negative cost base, each Appellant reported a capital gain of $24,136.00 on their 1993 T1 form.

[33] Subsequent to the disposition to Lobro Stables and on the same date, Lobro Stables, by agreement dated November 30, 1993, sold the interest it now owned in the Harrison property to an affiliate of Drewlo Holdings, called 643288 Ontario Limited ("643288"). Lobro Stables, at the time of transfer to 643288, owned two-thirds of a 50% beneficial interest in the Harrison property, with William Wasko owning one-third of a 50% beneficial interest. Again 722973 acted as bare trustee holding the beneficial interest in the property now for 643288. The total consideration paid by 643288 to Lobro and Wasko was the sum of $1,500,000.00, with the consideration being the assumption of a mortgage of $500,000.00 and a note payable to Lobro Stables for $666,667.00 and to Wasko for $333,333.00. On disposition of the property Lobro Stables reported a profit for its fiscal year, ending March 31, 1994 on disposition of the property. Since it had losses in prior years, the corporate tax payable was reduced to $6.00.

[34] Pursuant to Hill's memo, the Harrison property was now transferred to 643288, an affiliate of Drewlo Holdings.

[35] I do not believe that these transactions were artificial or manufactured. The legal relationships and their commercial reality are legitimate. The documents reflect the nature of these relationships. There is no evidence that they were backdated. The form they took on November 30, 1993 reflected the legal and accounting advice they sought. For me to reach any other conclusion would necessitate rejecting the evidence of both Appellants, William Drewlo and Bill Hill, all of whom presented consistent and uncontradicted evidence. The evidence of both Appellants, corroborated by Drewlo, established a consistent, plausible explanation of the background to the events of March 8, 1993 and November 30, 1993. After reviewing the evidence of Harry, William and Drewlo, I am simply not prepared to reject the evidence of all three individuals plus the evidence of their accountant.

[36] In respect to the cheque notations of March 8, 1993, the evidence of each Appellant and Drewlo was consistent. The March 8, 1993 cheques resulted from the mutual desire of these three individuals plus Wasko to quickly come up with money to tender on a development property. The three cheques were written at their solicitor's office after Drewlo agreed to loan money to the Appellants and Wasko.

[37] Both Appellants and Drewlo were adamant that the memo "Re: Sale 722973 Ont. Ltd." on the bottom left hand corner was not present when the cheques were signed at the solicitor's office or at the time of deposit. Harry's response concerning this notation was: "Those words were not on that cheque on March 8, all the time I had it in my possession". The evidence of both Appellants and Drewlo was that this memo was not on the cheques at the time of completion. Harry's evidence was that the cheques did not contain the memo when he deposited them. The bank's microfiche copies contained the same memo. I can speculate on the nature of the memo, for example, it may have been added to refer to the eventual sale of 722973 to Drewlo, and as the collateral to the loan in the event it was not repaid. If that were the case, the memo would refer to a future event and not the actual nature of the March 8, 1993 transactions. However the memo got on the cheques, I cannot agree that the acceptance and negotiation of these cheques, even with the notation, constitutes a valid and binding contract for the sale of land. I do not accept the Respondent's submissions that the sale occurred on March 8, 1993. It takes far more than mere passing of cheques with no further supporting documentation to transfer an interest in real property. The primary attributes of beneficial ownership are possession, use and risk (Johnson). The transaction date should be determined on objective evidence (Elias v. R., 2001 DTC 5674 (Fr.), 2002 FCA 319). There is no evidence that possession, use and risk associated with the property changed on March 8, 1993. It was the November 30, 1993 Agreements that changed these three items. The evidence of the Appellants and Drewlo is uncontradicted. They presented a plausible explanation of the events leading up to and surrounding the March 8, 1993 cheques. All three individuals denied that the notation was on any of the three cheques while in their possession. I accept their evidence, as there were no inconsistencies in their testimony. They were hard-nosed, successful businessmen who had long standing business relationships. Drewlo's evidence was that they often did things on a handshake. There was no need to involve tax advisors or lawyers at this point, as it was strictly a loan. If they had been successful in the tender bid, they felt they would have been able to repay the loan quickly. When we look at the November 30, 1993 Agreements, these individuals were quick to contact solicitors and accountants when the Appellants were forced to sell the Harrison property to Drewlo. There was nothing in their evidence to suggest that there was any type of commitment to sell the property on March 8, 1993. It was collateral to a loan only. In fact the evidence of the Appellants suggests that they really did not want to sell the property. They had owned it since the 1970s. They had never subdivided it and used it to grow hay most of the time.

[38] The cheques alone cannot be used to verify certainty of terms with respect to parties, property and price. According to the evidence of the Appellants and Drewlo, there was no oral agreement among these individuals to sell the property in March 1993. Upon examination of the events of March 8, 1993 and November 30, 1993, I can see no evidence of any change in the Appellants' beneficial interests in this property until November 30, 1993. No change in possession, risk and use occurred until November 30, 1993 and it only occurred on this date because the Appellants could not repay Drewlo. Drewlo is an impartial witness here who has nothing to win or lose in respect to the outcome. He obtained the property, which has apparently become quite valuable, because the Appellants could not repay him. I believe the documents and agreements reflect exactly what occurred here.

In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes.

[40] I conclude that the Appellants intended to do, on November 30, 1993, what the documents unequivocally state they were doing. Not only does the documentation support the transfer date of November 30, 1993 but so does the evidence. There is no cogent evidence to contradict these documents or to show that the parties intended to transfer on any other date.

[41] In addition to the cheques, the Respondent relied upon the accounting treatment and entries in respect to Drewlo Holdings (Exhibit A-1, Tab 25). These records prepared on February 1, 1994 show a recharacterization of the $1,000,000.00 payment to Harry, William and Wasko from an investment to an account receivable. The Respondent pointed out that the non-consolidated balance sheet of Drewlo Holdings stated that "as at October 31, 1993", the $1,000,000.00 was listed as an account receivable. Given the preparation date of 1994, it was argued that it had been re-characterized from an investment to an account receivable.

... I am not prepared to treat these accounting entries as reflecting the true legal relationship between the appellant and Felsen. Accounting entries are supposed to reflect reality, not create it...

[43] The accountant testified that the change was a correction and not a recharacterization. On cross-examination when questioned why, in paragraph 7 of his memorandum (Exhibit A-1, Tab 30) to solicitor Donovan, he used the phrase "we propose to treat these advances as a loan during the interim period", he replied as follows:

And I'm going to suggest to you, sir, that you don't know what you're talking about. I did not re-characterize anything. I would not have re-characterize anything. I understood from Mr. Loyens and also from discussions with Mr. Drewlo, that the million dollars in March of 1993 was a loan. Had anyone told me that it wasn't and that the sale had occurred in March of 1993, I would not have done this in November. And I know that to be a fact.

[44] Mr. Hill was adamant that he made an adjusting journal entry to correct the initial recording of $1,000,000.00. I accept his testimony that he did not re-characterize the events of March 8, 1993. He acted on his discussions with the Appellants and Drewlo which gave birth to the November 30, 1993 memo. I have no reason to disbelieve him.

[45] The Respondent also relied on an adjusting debit note for Drewlo Holdings, contained in a Bank of Nova Scotia document dated March 2, 1994. The "particulars" box on this document contained the following wording:

Reversal of interest charges to Ardshell Limited on 722973 Ontario Limited from March 8th, '93 to Feb. 21, '94. See attached. Should be Drewlo Holdings Inc.

[46] The Respondent submits that this document proves that the sale of the property occurred March 8, 1993 because Drewlo Holdings paid interest on the mortgage from that date.

[47] Drewlo testified that he did not recall if a reversal in interest payments was in the negotiations when the transaction closed. The "particulars" box does refer to 722923 so I do believe this document refers to the Harrison property. It is also apparent from this banking document that Drewlo retroactively assumed the mortgage on the property effective March 8, 1993. Since Drewlo's evidence was consistent on all other points with that of the Appellants, I accept his testimony here that the interest adjustments were simply as he said, a "subsequent deal or a possible amendment to the deal". This would explain the retroactive nature of the interest adjustments. Drewlo did state that interest was never part of the negotiations between the parties on March 8, 1993. He stated: "... the thinking was at the time ... if we ... would have gotten the land we would have to make arrangements anyhow". I think it is clear that if they got the tender, they would quickly have to involve lawyers and accountants. His evidence was that they often went back and made adjustments on big land deals. I do not believe this type of negotiations would have been out of the ordinary for these businessmen.

[48] It was obvious from his testimony that Drewlo was clearly interested in obtaining the remaining 50% interest in the Harrison property. He indicated that the benefit of obtaining the Harrison property outweighed any interest payments. He was involved in business transactions worth millions of dollars with the Appellants. The Appellants were struggling financially at this time and Drewlo stated that they had many big deals where they would go back at a later date and readjust. I also believe that if one buys into the argument that Drewlo should have been concerned about six months interest, then one certainly has to answer why he would purchase in March and yet not bother to get the property legally transferred until almost nine months later.

[49] The Respondent referred to the lack of appropriate corporate resolutions on November 30, 1993, respecting the two interim transfers, that is the transfer to the Varna partnership and the transfer to Lobro Stables. The resolution of the Board of Director of 722973, which confirmed the share transfer, identifies the transfer as being from the Appellants to 643266. The resolution omits any reference to Varna or Lobro Stables. The Respondent suggested that form does matter and here the forms were inadequate. This supported a sale date of March 8, 1993, according to the Respondent. I do not agree. 722973 has no beneficial interest in the property. Its sole purpose is to act as bare trustee. Black's Law Dictionary (Seventh Edition) defines "bare trustee" as:

A trustee of a passive trust. • A bare trustee has no duty other than to transfer the property to the beneficiary.

The structure of the transaction does not require Varna or Lobro Stables to be included in these resolutions and share transfers. Mr. Hill's memo outlining the November 30, 1993 transactions had no reference to the inclusion of Varna and Lobro Stables in the resolutions of 722973. They certainly could have been included but their absence is not fatal. The shareholdings of 722973 were calculated on the percentage of beneficial interest in the property, but the beneficial interest in the property itself is independent of the shares. 722973's job as trustee was simply to track who owned the beneficial interests from time to time.

[50] The Respondent referred to several discrepancies surrounding the March 8, 1993 events. Firstly, why did the Appellants borrow more money than the $1,000,000.00 required for the tender bid? In reality the money required to inject into Ardshell by the Appellants and Wasko as their share of the bid on behalf of Walloy (remembering Walloy was a 50% shareholder of Ardshell along with Drewlo Holdings) was $500,000.00. The money to be loaned to Walloy was originally to be only $500,000.00 to cover their 50% share of the bid. According to Drewlo's evidence, he loaned the money to the Appellants and Wasko so they could inject some money into Ardshell to pay their share of the debt in that company. Remember, at this point Ardshell had some successful developments but had lost a great deal of money on the Hunt Club development and was struggling financially.

[51] Secondly, why did Walloy inject more money into Ardshell than necessary? Walloy deposited $700,000.00 into Ardshell; $200,000.00 over and above Walloy's 50% share of the $1,000,000.00 bid. The evidence supports that the excess amount went to pay Walloy's share of Ardshell's debts.

[52] Thirdly, why did the Appellants and Wasko receive $333,333.00 each from Drewlo? Wasko had a 50% share of Walloy with the Appellants retaining 25% each. Why then would the money be loaned to each of them equally? I think this can be answered easily. The loan was not to Walloy. It was a personal loan to these individuals, each of whom owned one-half of the Harrison property in equal shares. It is important to remember that all of these parties had a long-standing business relationship. According to the evidence of Drewlo and the Appellants, the loans were personal; partially to cover their share of the bid with the balance to allocate as they personally chose.

[53] Fourthly, was it mere coincidence that on the same day the Appellants and Wasko obtained a loan from Drewlo in the amount of $1,000,000.00, the value of the property was $1,500,000.00, which is exactly the amount to cover the $500,000.00 mortgage against the property plus the loan. The Appellants owned the Harrison property since the 1970s. Drewlo had purchased property adjacent to the Harrison property plus he had purchased a 50% share of the Harrison property from the Appellants. They were all shrewd businessmen involved for years in some aspect of land developing. To speculate that they may not have known the value of the property they were dealing with is just not plausible. In fact, on cross-examination, Drewlo himself agreed that he would not be disappointed if he got the remaining 50% of the Harrison property: "Like I said, I was always interested in the other 50% too".

[54] In summary, I accept the explanation for the events of March 8, 1993 and November 30, 1993 provided by the Appellants and Drewlo as plausible and credible. Their testimony is consistent and Hill's evidence supports their explanations that the sale occurred on November 30, 1993. The documentary evidence is insufficient to support a sale on March 8, 1993. I find no deception in completing the November 30, 1993 transactions and therefore there is no sham here. The disposition of the Harrison property occurred, as the Appellants claim, on November 30, 1993.

[55] The Respondent relied upon 227287 Alberta Ltd. v. The Queen, 97 DTC 1106 (T.C.C.), for the proposition that the March 8, 1993 transactions performed everything but the mere formal act of sealing the engrossed deeds, such that the completion relates back to March 8, the contract date. The application of the "Relation-Back" theory is subject to a test that was neither met nor pursued by the Respondent's counsel. As such, no further comments are necessary on this argument.

[56] Finally, I want to briefly address two items which came up during the hearing: the admissibility of the microfiche documents (Exhibit A-1, Tab 31) and the applicability of the Statute of Frauds. For the purposes of this appeal the Bank's microfiche copies of the three cheques have been admitted into evidence through the Book of Documents, although under protest by Appellants' counsel. Counsel argued that the microfiche copies were unreliable and might not be complete as there was no evidence pertaining to the creation and preparation of these documents.

[57] As I understand from the evidence on banking procedures, the original cheques are microfilmed before they leave the bank en route to a central clearing house. Apparently cheques are sent by midnight on the day of a deposit.

[58] The admissibility of business records is legislated through the Canada Evidence Act, R.S.C. 1985 c. C-5 ("CEA").

[59] The microfiche cheques were admitted into evidence (Exhibit A-1, Tabs 22-24). The weight to be given to the microfiche copies can be made with reference to J. Sopinka et al., The Law of Evidence in Canada, (Toronto, Butterworths 1999) which at page 18 states:

§ 2.14 Real evidence (also referred to as demonstrative evidence) cannot be produced before a court without prior testimonial evidence, or at least an admission, in order to establish the identity of the thing. The level of authentication required for admitting real evidence is relatively low. Once the evidence has been admitted, it is for the trier of fact to determine what weight to give it.

[60] The microfiche copies of the cheques, in addition to the photocopies of the cheques, were utilized by the Respondent's counsel to buttress the fact that the cheque notation was on the cheques at the time of deposit. Even if I gave little weight to the microfiche copies, it would not be detrimental to either party.

[61] The Appellants submitted that the Statute of Frauds states that an agreement concerning an interest in land is unenforceable by action unless evidenced in writing and signed. The Respondent submitted that the Income Tax Act works independently of the Statute of Frauds and is applicable only if there is a breach of contract and one party wants to enforce his or her rights. The Income Tax Act works in conjunction with the Statute of Frauds, not independently of it. However, the circumstances of this case do not require application of any of the provisions to the Statute of Frauds.

Issue Two: If the sale date is November 30, 1993, is the rollover of the Varna partnership interest to Lobro Stables valid pursuant to the application of subsections 85(1) and 85(1.1) of the Act?

Appellants' Position:

[62] Canada Tax Service, Stikeman's analysis of section 85 of the Income Tax Act, states that the transfer of a partnership interest is not a transfer of real property inventory. Therefore such a transfer does not violate paragraph 85(1.1)(f) of the Act.

Respondent's Position:

[63] The rollover of the partnership interest to Lobro Stables was technically flawed and invalid. The Varna partnership dissolved on November 30, 1993 because the transfer of both partners' interest to Lobro Stables as individuals violates partnership law. Lobro could not be the partner of Varna because there must be at least two partners to comprise a partnership. What was transferred to Lobro Stables was the Harrison property and not partnership interests.

Analysis:

[64] Section 85 allows a rollover of certain types of property to a Canadian corporation at cost, which results in a deferral of tax on disposition of a property. However only eligible property may be part of a rollover. Eligible property includes inventory but not real estate or real property that is inventory. It is defined in paragraph 85(1.1)(f) as:

(f) an inventory (other than real property, an interest in real property or an option in respect of real property);

[65] The Appellants were land developers, particularly in respect to large subdivisions. These appeals focus on the Harrison property. This property was classified as inventory. Generally the gain derived from the sale of inventory gives rise to income and not capital gain. The Appellants' accountant knew that the Appellants could not directly roll the Harrison property into Lobro Stables because of the limitation in paragraph 85(1.1)(f). It was desirable however that the property go to Lobro Stables because that corporation had non-capital losses which could be utilized.

[66] To circumvent the limitation contained in subsection 85(1), the Appellants looked to subsection 97(2). Subsection 97(2), unlike subsection 85(1), contains no similar limitation in respect to real property inventory. The Appellants were partners in the Varna Elevators partnership. The Harrison property was rolled into this partnership pursuant to subsection 97(2). Subsequent to this rollover, the partnership interest was then rolled into Lobro Stables.

[67] The Respondent stated that his research had revealed no case law on this particular point. Commentary by Vern Krishna, The Fundamentals of Canadian Income Tax, Sixth Edition (Toronto: Carswell, 2000) at 910, states:

11. Indirect Transfer of Land Inventory

Subsection 85(1) allows a taxpayer to transfer property to a taxable Canadian corporation on a tax-deferred basis. An important exception to this rule is that a taxpayer is not permitted to transfer land inventory on a tax-deferred basis to a corporation. There is, however, no explicit prohibition against transferring land inventory on a tax-deferred basis to a Canadian partnership. Hence, where a taxpayer wants to transfer land inventory to a corporation on a tax-deferred basis, the taxpayer can proceed in two stages. First, the taxpayer can form a partnership with the prospective purchaser of the property and transfer the land to the partnership, electing under subsection 97(2) to defer the gain on the transfer. The purchaser can contribute a nominal amount of cash for the partnership interest. Second, the vendor can transfer his or her partnership interest to the purchaser corporation in consideration for shares with a fair market value equal to the value of the partnership interest, and the parties may then elect under subsection 85(1) in respect of the transfer. On the acquisition by the purchaser corporation of the taxpayer's partnership interest, the partnership ceases to exist and subsection 98(5) applies to deem the purchaser to have acquired the land at an amount equal to the taxpayer's cost amount for the land.

As a consequence of this two-step arrangement, the purchaser corporation acquires the land inventory and the taxpayer avoids the recognition of any gain on the transfer of the property.

[68] The Respondent's argument has some merit but I believe it may apply only to a situation where the subsection 85(1) rollover of the partnership interest to the company is occurring at the same moment in time. Section 2 of The Ontario Partnership Act requires that a valid partnership have a minimum of two partners. The evidence in this appeal supports the view that the transfer of the Appellants' partnership interests did not occur simultaneously. The transfers of the Appellants' respective interests in Varna to Lobro Stables are contained in two separate and distinct documents (Exhibit A-1, Tabs 20 and 20.1). This is noticeably different from the agreement in which each of the Appellants' interest in the Harrison property was rolled into the Varna partnership (Exhibit A-1, Tab 19). This was accomplished using only one document. This clearly supports my conclusion that the subsection 85(1) rollovers of the partnership interests of each Appellant occurred one at a time and not simultaneously. I consider this clear and unequivocal evidence that, although the documents were dated the same day, the transfers occurred one at a time even though moments apart. For example, I assume William transferred his interest in Varna to Lobro first. The result is that Harry and Lobro Stables become the partners in Varna. Subsequently, by separate agreement, although only moments after, Harry executes a transfer document rolling his interest to Lobro Stables, which has now acquired the entire partnership interest. Subsection 98(5) contemplates this type of situation where one partner continues to carry on the business of the former partnership when the other partner has left. Pursuant to subsection 98(5) the partner carrying on the business of the former partnership acquires the assets of the former partnership at cost base. In drafting two separate documents, I believe it is easily inferred that this was clearly part of the overall design that this tax plan was intended to reflect. Otherwise everything would have been included in the one agreement as occurred with the subsequent transfer to Lobro Stables. Thus, the rollovers are technically valid.

[69] In the circumstances of this case, the subsection 85(1) rollovers are therefore technically valid.

Issue Three: Does the general anti-avoidance rule, section 245 of the Act, apply?

[70] This issue was argued by the Respondent in the alternative.

Appellants' Position:

[71] It is conceded that in accessing losses in Lobro Stables there was a tax benefit to the Appellants, a condition precedent to the application of section 245. It is also conceded that there was quite clearly a series of transactions, being the November 30, 1993 Agreements, but that there was no misuse of the relevant provisions of the Act or an abuse of the provisions of the Act as a whole.

[72] OSFC Holdings Ltd. v. R., 2001 DTC 5471 can be distinguished from the present case because in OSFC Holdings Ltd. arm's length persons purchased losses incurred by the Appellants. The transactions were specifically designed to sell losses. The overall purpose of the November 30, 1993 transactions however was to sell the Harrison property in the most tax efficient manner. Counsel also submitted that it is the whole transaction that must be viewed and that it was incorrect to artificially split off or isolate various components of the overall transaction in order to create an avoidance transaction.

[73] If these transactions are not preserved from the application of GAAR by subsection 245(3), then the relevant policy behind the provisions and the Act must be clear and unambiguous to allege misuse and abuse. Justice Rothstein's comments in OSFC Holdings Ltd. make it clear that it is up to the Respondent to explain the clear and unambiguous policy behind the provisions of the Act. They simply have not done so.

Respondent's Position:

[74] Section 245 is not meant to interfere with legitimate commercial transactions. It applies when the purpose of the transactions is an avoidance of tax. In this case, the Appellants should have sold the Harrison property directly to Eugene Drewlo or his designate without going through the numerous steps of the November 30, 1993 transactions.

[75] Contrary to the Appellants' position, the proper approach in determining whether the transactions were undertaken for a purpose other than a tax benefit is to look at the individual transactions that make up the series.

[76] With respect to the misuse of the provisions or abuse of the Act as a whole, the Respondent submitted that when the policy is clear there is no need to refer to extrinsic evidence to establish the object and spirit of the provisions, per Justice Noel's remarks in Water's Edge Village Estate (Phase II) Ltd. v. The Queen, 2002 DTC 7172 (leave to appeal to Supreme Court of Canada denied on March 20, 2003). The policy behind paragraph 85(1.1)(f) is that the rollover of real property inventory is prohibited.

[77] To avoid the prohibition against the transfer of real property inventory to a corporation pursuant to paragraph 85(1.1)(f), the Appellants utilized subsections 97(2) and 85(1) in a manner which amounted to misuse of these provisions. Section 245 should be applied to deny the rollovers and the profit realized on the Harrison property should be included in the income of the Appellants.

[78] OSFC Holdings Ltd. says loss trading is prohibited. This case is a mirror of OSFC Holdings Ltd., that is, loss trading is interchangeable with profit trading. The Appellants transferred the profit on the sale of the Harrison property to their corporation to use the corporation's losses. That is an abuse of the Act as a whole.

Analysis:

[79] Several Federal Court of Appeal decisions have established the analytical framework within which GAAR is to be applied; in particular the decisions of cites OSFC Holdings Ltd. and Water's Edge Village Estate (Phase II) Ltd. and most recently NovopharmLimited v. The Queen, 2003 FCA 112. The decision in Novopharm, although it was in respect to the former subsection 245(1), has firmly established that the approach taken in Canada v. Fording Coal Ltd., [1996] 1 F.C. 518 is the correct one and that it is the preferred approach over that taken in Canada v. Mara Properties Ltd., [1995] 2 F.C. 433. For section 245 to apply the following questions must be addressed:

(1) Was there a series of transactions within the meaning of section 245, and if so, which transactions were parts of that series?

(2) Did the November 30, 1993 transactions result in a tax benefit to the Appellants?

(3) If so, can the transactions reasonably be considered to have been undertaken primarily for a purpose other than to obtain the tax benefit?

(4) If not, did the transactions result in a misuse of the provision of the Act or an abuse having regard to the provisions of the Act, other than section 245, read as a whole?

[80] The Appellants' counsel concedes the first two factors. First, the series of transactions occurring on November 30, 1993 were: the transfer of the Harrison property by the Appellants to the Varna partnership, the transfer of this same property from Varna to Lobro Stables and the transfer of the property from Lobro Stables to 643288. Second the November 30, 1993 transactions allowed the Appellants to access losses in Lobro Stables, resulting in the tax benefit.

Primary Purpose:

[81] There is a tax benefit here so there must be a determination of the primary purpose of the transaction or any of the transactions in the series. If the primary purpose is to obtain a tax benefit, then it is an avoidance transaction.

[82] The Respondent's counsel argues that each transaction within the series must be analyzed and if the primary purpose of any one of the transactions within the series is to obtain the tax benefit, then it is considered an avoidance transaction within subsection 245(3). The Respondent relies on OSFC Holdings Ltd. where at paragraph 45 it states:

Once it is determined that a series of transactions results in a tax benefit, any transaction that is part of the series may be found to be an avoidance transaction. The question is the primary purpose of each of the transactions in the series. If the primary purpose of any transaction is to obtain the tax benefit, it is an avoidance transaction.

[83] The Appellants' counsel contends that the series of transactions as a whole or in their entirety should be looked at to determine the purpose behind those transactions. The Appellants cite The Queen v. Canadian Pacific Limited, 2001 F.C.A. 398 (F.C.A.) for the proposition that the series of transactions on November 30, 1993 must be examined as a whole. Paragraph 27 of this decision quotes from the Tax Court of Canada decision as follows:

The transactions which the Respondent says constitute the series were, when viewed objectively, inextricably linked as elements of a process primarily intended to produce the borrowed capital which the Appellant required for business purposes. The capital was produced and it was so used. No transaction forming part of the series can be viewed as having been arranged for a purpose which differs from the overall purpose of the series. The evidence simply does not support the Respondent's position. Accordingly none of the transactions on which the Respondent relies was an avoidance transaction within the meaning of s. 245(3).

[84] The quote from Canadian Pacific Limited is a determination based on the facts of that case and not a general proposition. My reading of that case is that one transaction within a series of transactions cannot be further divided into separate components for the purpose of finding one of those components an avoidance transaction.

[85] It is clear from the Fording approach utilized in the case of Novopharmthat the entire series of related transactions must be considered and not just the one transaction that gave rise to the benefit.

[86] There are three transactions occurring on November 30, 1993. According to OSFC Holdings Ltd. it is necessary to analyze the primary purpose of all of the relevant transactions in the series. The primary purpose of each transaction must be determined on the facts at the time the transaction occurred. Justice Rothstein in OSFC Holdings Ltd. stated at paragraph 46:

The words "may reasonably be considered to have been undertaken or arranged" in subsection 245(3) indicate that the primary purpose test is an objective one. Therefore the focus will be on the relevant facts and circumstances and not on statements of intention. It is also apparent that the primary purpose is to be determined at the time the transactions in question were undertaken. It is not a hindsight assessment, taking into account facts and circumstances that took place after the transactions were undertaken.

[87] The most direct route for the transfer of the Harrison property would have been from the Appellants to Drewlo. After these individuals struck the deal they contacted their tax advisor. He devised the necessary steps to accomplish transfer of the property so that the accumulated losses in Lobro Stables could be accessed. According to both Appellants they simply referred this matter to Hill for tax advice as they had probably done innumerable times in the past as land developers. Drewlo wanted the property and was prepared to go along with whatever steps Hill recommended, as long as it did not affect him adversely.

[88] According to both Hill's testimony and his memo (Exhibit A-1, Tab 30), which outlined the steps to effect transfer of the property on November 30, 1993, it was clear that it would be beneficial if the Appellants could access losses in Lobro Stables. These losses had been legitimately accumulated. Accessing these losses could not be accomplished directly because of the prohibition in paragraph 85(1.1)(f) against the rollover of real property inventory to a corporation. However if the Varna partnership could be used, then under subsection 97(2) the Appellants could transfer their interest in the property to their partnership. The Appellants would then be free to transfer the partnership interests (which included the Harrison's property) to Lobro, as there is no similar prohibition against rolling partnership interests. The existing Varna partnership and Lobro Stables were introduced into the November 30, 1993 transactions to facilitate obtaining the tax benefit under the relevant sections of the Act. The memo content clearly supports this, as does Hill's evidence.

[89] I conclude that the primary purpose of each of these transactions and the transactions as a whole on November 30, 1993 was to obtain the tax benefit.

Misuse/Abuse:

[90] Subsection 245(4) excludes from the operation of subsection 245(2) those transactions that do not result "directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole". Since the test here is an objective one, it is the relevant facts that are to be considered and not the taxpayer's intention.

[91] Which provisions are being misused? The provisions in question are subsections 97(2) and 85(1). Section 85 allows a rollover of certain types of property to a corporation at cost. Utilization of the provision results in a deferral of tax on a disposition of property. However the section is strictly controlled. Only eligible property qualifies for election under subsection 85(1). Eligible property is listed in paragraph 85(1.1)(f). Subsection 97(2) differs most materially from subsection 85(1) in that there is no similar prohibition and real property that is inventory is eligible for rollover under subsection 97(2) but not under subsection 85(1).

[92] The Appellants' accountant was able to indirectly roll the real property inventory, the Harrison property, to Lobro Stables, when the Appellants could not do so directly. By introducing the Varna partnership and utilizing subsection 97(2), the Appellants were able to utilize the losses in Lobro Stables to offset the gain on the Harrison property sale.

[93] To determine the existence of misuse, the first step is to determine the policy behind the provision. Misuse depends upon the object and spirit of the particular provisions, sections 97 and 85. In this case, the Appellants and the Respondent have different views as to what the policy is behind paragraph 85(1.1)(f).

[94] The Respondent argues that subsection 97(2) is the mechanism used by the Appellants to circumvent the definition of eligible property found in paragraph 85(1.1)(f). This results in misuse of these sections by allowing the Appellants to avoid a gain that should otherwise have been included in their income.

[95] The Appellants submit that there is no misuse as there is no violation of the policy behind the real property inventory restriction, which is to prevent a trader in real property from converting income into capital gains by rolling property into a corporation and then selling shares of the corporation.

[96] The Respondent has summarized the effect of the provisions without attempting to clarify the policy behind the sections. It is merely a reiteration of the sections, with no guidance on what the underlying policy is behind the provisions.

[97] The Respondent's counsel argues that the relevant provisions here are so clear that outside aids or extrinsic evidence of policy are not required. Counsel contends that the object and spirit is sufficiently reflected in paragraph 85(1.1)(f), where it states clearly that real property inventory cannot be part of the rollover.

[98] Justice Rothstein in OSFC Holdings Ltd. clearly set out that the Court's role is to identify a relevant, clear and unambiguous policy. He goes on to state that a Court cannot make a finding of misuse or abuse where Parliament has not been clear and unambiguous as to its intended policy. At paragraph 68 of his Reasons for Judgment he states:

Ascertaining the relevant policy is a question of interpretation. As such it is ultimately the duty of the Court to make this determination. There is no onus to be satisfied by either party at this stage of the analysis. However, from a practical perspective, the Minister should do more than simply recite the words of subsection 245(4), and allege that there has been misuse or abuse. The Minister should set out the policy with reference to the provisions of the Act or extrinsic aids upon which he relies. Otherwise he places the taxpayer and the Court in the difficult position of trying to guess the relevant policy at issue. Trying to ascertain the policy of a specific provision or of an Act as a whole, in the case of an Act as complex as the Income Tax Act, is a difficult exercise, particularly when the transaction in question conforms to the letter of the Act. Therefore, the Court requires the assistance of the parties to enable it to reach a correct conclusion. Nonetheless, with or without that assistance, the Court must attempt to determine the relevant policy. Of course, at the next stage, once the policy is determined, the onus remains on the taxpayer to prove the necessary facts to refute the Minister's assumptions of fact that the avoidance transaction in question results in a misuse or an abuse.

[99] The Respondent cites Water's Edge Village Estates (Phase II) Ltd. to support his contention that if the policy is clear from the provisions, no extrinsic evidence is required. The Respondent relied on comments by Justice Noël at paragraph 48 which reads:

Indeed, the object and spirit of the relevant provisions is so clear that I questioned during the hearing whether the Tax Court Judge properly concluded, and the Minister properly conceded, that the Act when construed without regard to section 245, allowed Klink to deduct the terminal loss. There exists a number of cases where the words of the Act were given a distinct meaning derived from the object and spirit of the Act in a context that bears some resemblance to the present case (Lea-Don, supra; Allied Farm Equipment Ltd. v. M.N.R., [1972] F.C. 263 (F.C.A.); Oceanspan Carriers Ltd. v. Canada [1987] 2 F.C. 171 (F.C.A.); Holiday Luggage Mfg. Co. v. Canada, [1987] 2 F.C. 249 (Trial Division)). In all of these cases, the Court relying on the scheme of the Act or its object and spirit, refused to extend its application to persons while not subject to tax thereunder.

[100] Although these remarks seem to support the Respondent's argument that extrinsic evidence is not necessary in certain situations, Justice Noël did rely upon factors outside the provision in making that statement. He looked to the objectives of the CCRA system as a whole before determining the policy. I do not accept that these remarks were meant to be a blanket statement that might override the approach of Justice Rothstein in OSFC Holdings Ltd. In this case, I do not believe the policy is as clear as Respondent contends, and where that is so, then Respondent's counsel has an obligation to refer to materials that might have assisted me in formulating a policy behind these provisions.

[101] With nothing more from the Respondent than a reformulation of what the provisions state, I could simply conclude that there is no misuse. However, Appellants' counsel referred me to outside material to help ascertain the policy.

[102] I was referred to commentary by Krishna and Stikeman to support the proposition that the policy behind paragraph 85(1.1)(f) is to prevent a real property trader from converting income into capital gains. V. Krishna, Krishna's The Fundamentals of Canadian Income Tax, Sixth Edition at p. 940, states:

(a) Inventory

The exclusion of real property inventory from eligible property is intended to prevent a real estate trader from converting business income into a capital gain by selling inventory to a corporation and then selling the shares of the corporation for a capital gain. Such a transformation of business income into a capital gain would in any event probably fail. Subsection 85(1), however, adds certainty through its outright prohibition of the use of the rollover for real property inventory.

The distinction between capital property and business inventory depends on the intention of the taxpayer who disposes of the property. Therefore, it may be difficult to determine with certainty whether real estate does or does not qualify for the rollover under subsection 85(1). Since the characterization of real estate gains and losses depends on the factual circumstances surrounding its ownership, it is not possible to obtain an advance ruling on its status from the CCRA. In cases of doubt, it may be prudent not to transfer real property that may later be determined to constitute inventory.

Canada Tax Service - Stikeman Analysis in referring to paragraph 85(1.1)(f) of the Act states:

The real property exclusion presumably was considered to be required partly in order to prevent the transfer by a real estate trader of inventory to a corporation under subsection 85(1) and the subsequent sale of the shares of that corporation. This could effectively accomplish a transformation of income into a capital gain. However, there is case law to the effect that in such circumstances the sale of shares would give rise to income and not a capital gain and, moreover, could well trigger a recapture of capital cost allowance claimed in respect of the real property concerned. See Fraser v. Minister of National Revenue, [1964] C.T.C. 372; Belle-Isle v. Minister of National Revenue, [1966] C.T.C. 85; Gibson Brothers Industries Ltd. v. Minister of National Revenue, [1972] C.T.C. 221 (FTCD); Burgess et al v MNR, [1973] C.T.C. 59; and Dumas v. Minister of National Revenue, [1989] 1 C.T.C. 52 (FCA): (see also the commentary to section 9, "Real Estate Profits Realized through the Sale of Shares"). Some of these cases may suggest that the transfer of shares in such circumstances may in substance be a transfer of real property that is inventory and therefore not permissible under subsection 85(1). See also the commentary to section 54.2. (Emphasis added.)

[103] Both of these commentaries concur that the purpose behind the real property inventory restriction in subsection 85(1) is to prevent the conversion of income into capital gains by a real property trader. In the facts before me does the tax planning convert business income to capital gains? Clearly that did not occur here. The transfer to the Varna partnership resulted in reporting of taxable business income as did the transfer of the partnership interest to Lobro Stables. And ultimately, in the disposition by Lobro Stables to 643288, the gain was reported as business income. Proof of this is reflected in the tax returns and in the evidence of Mr. Hill. There is no conversion of business income to capital gains here. It seems to me that this view is much more consistent with the policy objectives behind the provisions.

[104] Quite apart from the absence of any extrinsic evidence or materials offered by the Respondent, I accept these commentaries as the policy behind these provisions. If the policy was crystal clear it would not have garnered commentaries from both Stikeman and Krishna. The most telling tale is this: If the policy was so clear, the same prohibition could very easily have been included in subsection 97(2). That was not done.

[105] Has the above policy been violated? The policy behind paragraph 85(1.1)(f) is to prevent a real property trader from converting income into capital gains. Do the facts suggest that the Appellants violated this policy? No, they do not. All moneys related to the Harrison property were reported as income at every stage. There is no misuse of the provisions because the policy of converting income to capital gains is not violated.

[106] When I look to the particular facts of this case, they suggest no misuse of the provisions of the Act. The purpose behind the exclusion of land inventory from the definition of "eligible property" in subsection 85(1.1) is to prevent a taxpayer from converting what would otherwise be income into capital gains by using subsection 85(1). Here, the gain on the sale of the Harrison property was reported as income and not as capital gain. Therefore, the policy behind the provisions has not been violated and as a corollary, there is no misuse.

[107] The final matter in the GARR analysis which is whether there has been an abuse of the provisions of the Act as a whole.

[108] The Respondent's position is that the Canadian tax system is based on calculating tax separately for each taxpayer. The policy of the Act prohibits the sharing of income (per Mersey Docks & Harbour Board v. Lucas, (1882-83) 8 A.C. 891 (H.L.) and Woodward's Pension Society v. M.N.R., 59 DTC 1253 at 1261 and affirmed at 62 DTC 1002). Counsel then relied on Justice Rothstein's remarks in OSFC Holdings Ltd. that the general policy of the Act is against loss trading by corporations, subject to certain exceptions. The Respondent argued that whether it is loss or profit, there is no difference between the two. Counsel then combined these propositions to argue that the term "loss" is interchangeable with the term "profit" and deducted that profit trading is therefore prohibited under the Act.

[109] The Appellants' counsel argues that the decision OSFC Holdings Ltd. is distinguishable because the Appellants were not involved in selling of losses.

[110] As part of his argument Respondent's counsel referred to the cases of Woodward's Pension Society and Mersey Docks & Harbour Board (upon which Woodward's Pension Society relied) as authorities for the proposition that the sharing of income is prohibited under the Act. Woodward's Pension Society dealt with the issue whether a predestined purpose for future income can change the taxability of that income. Both cases involved non-profit corporations that were producing profit to distribute the income in a manner consistent with its objectives. The Courts held that despite the virtuous fate of the profit, it was still profit to the non-profit corporation and therefore tax was payable on the income. From my reading, I do not see how the Respondent can glean any remarks that support the proposition that profit sharing is prohibited. I also believe that his interpretation of OSFC Holdings Ltd. is flawed. Clearly OSFC Holdings Ltd. prohibits loss trading. However, I would not extend the principles enunciated in OSFC Holdings Ltd. with respect to loss trading to conclude that profit trading is interchangeable with loss trading. There is nothing in OSFC HoldingsLtd. that even hints at such substitution. The factual situation in OSFC Holdings Ltd. was entirely different. It involved strangers acquiring tax entities built on losses incurred by others. The Federal Court of Appeal in OSFC Holdings Ltd., in concluding that loss trading between corporations is against the general policy of the Act, states that the present policy is to allow refunds or transfer of losses on a strictly controlled basis. Specifically paragraph 94 of the decision states:

...Refundabilitytreats annual losses and profits symmetrically. It improves neutrality in the tax system. It eliminates discrimination against more risky businesses that have more volatility in earnings than less risky businesses. It may improve competitiveness and market efficiency by allowing firms to enter and exit industries more readily.

(Emphasis added.)

[111] Gain trading is allowed to some degree. There is further evidence that profit trading is not interchangeable with loss trading as they currently receive fundamentally different treatment within the Act.

[112] There are additional sources to support this conclusion. Krishna has relevant commentary. According to Krishna, a section 85 rollover of property from an individual to a related corporation is generally acceptable. Specifically Krishna states:

7. - Section 85 Rollover to Related Corporations

Suppose an individual has property with an unrealized capital gain that the individual wishes to sell to a third party. The individual also has a related corporation with net capital loss. If he or she sold the property directly to a third party, a capital gain would be realized. To avoid the gain, the property is transferred to the individual's related corporation on a tax-deferred basis under subsection 85(1). The related corporation then sells the property to the third party and offsets the resulting taxable capital gain against its net capital loss.

It is clear that such a transaction is tax motivated and, without more, would be an avoidance transaction. The CCRA does not, however, consider a transfer of property to a related corporation on a tax-deferred basis to contravene the object and spirit of the Act. Since subsection 69(11) does not permit a person to transfer property to an unrelated corporation on a tax-deferred basis where it is intended that the unrelated corporation will sell the property and reduce the amount of the gain by amounts of losses or similar deductions which it may claim, the Agency reasons that "... by implication, the subsection does permit a transfer to a related corporation on a tax-deferred basis."*

The Agency does not address the broader question of whether the grouping of income and losses of a related corporate group is within the general scheme of the Act with respect to consolidated income reporting for tax purposes. This may suggest that in applying GAAR, the CCRA is less likely to be concerned with the general scheme of the Act read as a whole and more concerned with the misuse of specific statutory provisions.

[113] The above remarks can be cross referenced to an example in Information Circular 88-2, General Anti-Avoidance Rule - section 245 of the Income Tax Act to which the Appellants referred. This circular deals with the example of an individual rolling property to a related corporation so that gains from the sale could be offset by losses in the corporation:

9. - Facts

A person has property with an unrealizedcapital gain that it wishes to sell to a third party. A related corporation has a net capital loss. Instead of selling the property directly to the third party and realizing a capital gain, the person transfers the property to the related corporation and elects under subsection 85(1) to defer the recognition of the gain. The related corporation sells the property to the third party and reduces the resulting taxable capital gain by the amount of its net capital loss.

Interpretation

Subsection 69(11) does not permit a person to transfer property to an unrelated corporation on a tax-deferred basis where it is intended that the unrelated corporation will sell the property and reduce the amount of the gain by amounts of losses or similar deductions which it may claim. By implication, the subsection does permit a transfer to a related corporation on a tax-deferred basis. In these circumstances such a transfer would be acceptable as it is within the object and spirit of the Act.

(Emphasis added.)

[114] I conclude that the general rule against loss trading has no equivalent rule when it comes to profit trading.

... It should not be used routinely every time the Minister gets upset just because a taxpayer structures a transaction in a tax effective way, or does not structure it in a manner that maximizes the tax.

Simply put, using the specific provisions of the Income Tax Act in the course of a commercial transaction, and applying them in accordance with their terms is not a misuse or an abuse.

[117] Those remarks are equally applicable to these appeals. Taxpayers are free to structure their transactions in a tax effective manner, thereby reducing the tax otherwise payable, and they have done so here.

[118] The Appellants struck a deal with a long-standing business partner. The first place they contacted was their tax advisor's office. He used the provisions of the Act in conjunction with a pre-existing partnership and corporations to structure the Appellants' agreement with Drewlo in the most tax efficient manner. The transactions were in accordance with normal business practice and were entered into for bona fide purposes (part of Fording approval applied in Novopharm). This does not amount to a misuse or abuse of the provisions of the Act. It is simply utilizing them for the very purpose for which they were designed.

[119] Interference with legitimate legal relationships through the application of section 245 must of necessity be one of last resort. This is not one of those cases.

Issue Four: Is the waiver received by the CCRA on behalf of Harry a valid and effective waiver?

[120] Pursuant to subsection 152(4) of the Act, the three year limitation period was to terminate on September 1, 1997 with respect to reassessment of Harry's 1993 taxation year. On August 12, 1997 the auditor wrote to Harry requesting a waiver. It was copied to his accountant. On August 20, 1997 the auditor's original letter to Harry together with a signed waiver dated August 16, 1997 was returned to the auditor. He did not verify the signature on the waiver. The signature is not Harry's but it was agreed at the hearing that it is the signature of his brother, Frank. Harry was not in the Province during this period. Frank had worked for Walloy years before and had occasionally signed employee pay cheques for Harry during that time. The accountant recalled receiving a copy of the letter requesting the waiver but he did not recall and had no notes of any discussions with Harry concerning the waiver.

[121] The Appellant's position is that the waiver is invalid because Harry did not sign the form, was out of the Province at the time, never received it personally and there is no evidence that he was aware of or had any knowledge of the waiver. His brother, Frank, signed for Harry but Frank had no authority to do so. Any signing authority Frank had, ended years ago. James Atkinson, auditor for the CCRA, should have checked the signature on the waiver as he had other documents in his possession to use for comparison. In Mitchell v. The Queen, 2002 FCA 407, the Federal Court of Appeal discusses waivers. The decision supports the view that in order to have an effective waiver, there must be knowledge on the part of the taxpayer. Harry had no such knowledge.

[122] The Respondent's position is that estoppel prevents Harry from arguing this is an invalid waiver because he is bound by Frank's signature on the waiver. Therefore the CCRA has a valid waiver and could reassess outside the period. The auditor acted appropriately in proving the waiver and it was reasonable for CCRA to place reliance on it. The requested waiver was returned several days after it was sent and there is no duty on the CCRA official to check every signature. He complied with any due diligence requirements.

[123] Based on my disposition of the first three issues, there is no requirement for an analysis and decision in respect to the waiver issue. However, I would like to provide a few short comments in respect to the arguments of the Appellants' and Respondent's counsel. The Mitchell case referred to by both counsel while providing a review of waivers generally, concentrates on the information contained in the waiver and whether certain letters amounted to an effective waiver. The issue in this case focuses on the signature on the waiver and not the information contained in the form. Consequently, I did not find the Mitchell case particularly helpful.

[124] A waiver is a consensual arrangement between the taxpayer and the Crown to delay the process of assessment and enable the parties to negotiate a determination of potential liability. The form itself (Tab 32 of Exhibit A-1) contains a paragraph which states:

This waiver must be signed by the taxpayer or legal representative...

[125] The facts disclosed that Harry did not sign the waiver and that, not only was his brother Frank not his representative, he was certainly not his representative, legal or otherwise.

[126] Atkinson's actions were reasonable in the circumstances when he accepted the signed waiver without any further investigation. As I see it however, this does not make a waiver valid when the form specifically calls for a taxpayer or a legal representative to sign the waiver.

Conclusion

[127] The appeals are allowed, with costs, and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the first and second Reassessments for the 1993 taxation year be vacated.

In order that the sale of a real estate property could be accomplished in a manner that utilized the losses of a loss company ("Lobro Stables") the taxpayers transferred the property to a partnership utilizing the rollover in subsection 97(2), transferred their partnership interests to Lobro Stables utilizing the rollover provision of subsection 85(1), with Lobro Stables then selling the property at a gain.

In finding that these transactions did not result in an abuse or misuse for purposes of s. 245(4), Campbell T.C.J. stated that the principles in OSFC Holdings with respect to loss trading should not be extended to profit trading, and the transactions simply utilized the provisions of the Act for the very purpose for which they were designed.

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